The markets are tightening! Where is the Fed?

The markets are tightening because risk keeps rising. Why?

The 3-month Eurodollar rate is climbing because of rising risk due to lack of liquidity (click on chart to enlarge).

This is what is happening (source: Bloomberg).

The U.S. commercial paper market shrank for a third week, extending the biggest slump in at least seven years and signaling that the Federal Reserve's attempts to lower borrowing costs have had a limited impact so far.

Asset-backed commercial paper, which accounted for half the market, tumbled $59.4 billion to $998 billion in the week ended yesterday, the lowest since December, according to the Federal Reserve. Total short-term debt maturing in 270 days or less fell $62.8 billion to a seasonally adjusted $1.98 trillion. The yield on the highest rated asset-backed paper due tomorrow rose today 0.11 percentage point to a six-year high of 6.15 percent.

The Fed lowered the interest rate it charges to lend to banks to encourage buyers of commercial paper after the market seized up for Thornburg, Countrywide Financial Corp. and other mortgage lenders.

The Fed ``failed to bring money markets back to normal,'' John Lonski, chief economist at Moody's Investors Service in New York, said in an interview. ``Credit markets are obviously in need of a rate cut.''

In a sign that buyers are still favoring safer assets, an $18 billion auction yesterday for two-year U.S. government debt drew the most demand since 1992.

Bottom line. The markets always win. The markets are telling the policy makers they are behind the curve in handling what is happening. The markets are tightening. This is bad news.

The global central banks will be forced to lower short-term interest rates in a major way and inject large amounts of liquidity.

Of course this situation will have a major impact on all financial markets from commodities to stocks.

More on http://www.peterdag.com/.

George Dagnino, PhD
Editor, The Peter Dag Portfolio
Since 1977